What Fees Can You Pay with Funds from a 1031 Exchange (Without Triggering Tax Liability)?

When conducting a 1031 exchange, any gains you reinvest into the purchase of a replacement property are eligible for indefinite tax deferral. Conversely, any gains that you do not reinvest (which are classified as “boot”) are subject to immediate taxation under the Internal Revenue Code. But, what about fees and costs associated with the exchange process itself—are these eligible for deferral? Find out from an experienced 1031 exchange specialist:

Understanding the Tax Treatment of Fees and Costs During a 1031 Exchange

Many of the fees and costs associated with conducting a 1031 exchange are eligible for indefinite tax deferral. This means that as long as you comply with the requirements (including the strict deadlines) for conducting a compliant 1031 exchange, you can use gains from the sale of your relinquished property to pay these costs and fees without triggering federal tax liability.

The fees and costs that real estate investors can pay without triggering federal tax liability generally include:

• Real Estate Commissions – Any commissions paid to a real estate agent or broker in connection with a like-kind exchange are eligible for indefinite tax deferral under Section 1031.
• Qualified Intermediary Fees – Conducting a compliant 1031 exchange generally involves working with a qualified intermediary. The qualified intermediary’s fees are also eligible for indefinite tax deferral.
• Escrow Fees – Escrow fees incurred in connection with a like-kind exchange are eligible for deferral as well.
• Filing Fees – Filing fees incurred for recording deeds and meeting other applicable legal requirements are also eligible for deferral.
• Legal Fees – If you hire an attorney to assist with your 1031 exchange, your legal fees may be eligible for deferral.
• Title Insurance Premiums – Finally, title insurance premiums are also generally eligible for deferral under Section 1031 of the Internal Revenue Code.

To be clear, these costs and fees are eligible for indefinite tax deferral when they are paid using proceeds from the sale of a relinquished property. If you use other funds, different tax rules apply.

Costs That Are Not Eligible for Indefinite Tax Deferral Under Section 1031

While some costs and fees are eligible for indefinite tax deferral when paid out of the proceeds of the sale of a relinquished property, others are not. Some examples of costs that are not eligible for deferral include:

• Property Taxes – Gains used to pay any property taxes that you owe in connection with your like-kind exchange will generally be ineligible for federal income tax deferral.
• Other Insurance Premiums – Aside from title insurance premiums, other types of insurance premiums are also generally ineligible for deferral under Section 1031.
• Repair and Maintenance Costs – Unless you properly structure an improvement exchange, gains used to cover costs you incur for property repair and maintenance will be ineligible for deferral.

Again, these are just examples. To avoid violating the Internal Revenue Code (and potentially triggering an IRS audit), investors who are conducting 1031 exchanges must be extremely careful to ensure that they do not attempt to inappropriately defer any of their federal income tax liability.

Maximizing the Financial Benefits of a 1031 Exchange

Ensuring that you are able to maximize the benefits of conducting a like-kind exchange under Section 1031 is one of the main reasons to work closely with an experienced 1031 exchange specialist. From ensuring that you meet the applicable deadlines under Section 1031 to assisting with structuring an improvement exchange (or delayed or reverse exchange) if desired, an experienced specialist will be able to assist in several important ways. Since mistakes that trigger immediate tax liability generally cannot be undone, it is imperative to ensure that you make informed and strategic decisions throughout the exchange process.

Our 1031 exchange specialists are also qualified intermediaries; and, as a result, we are able to guide investors through all phases of the exchange process. We can help you maximize the benefits of the process while also helping you avoid costly mistakes, and we can also help ensure that you have the documentation needed to withstand an IRS audit if necessary.

Talk to a 1031 Exchange Specialist for Free

If you would like to know more about the fees and costs you can pay with funds from a 1031 exchange, or if you have any other questions about the 1031 exchange process, we invite you to get in touch. We are more than happy to explain everything you need to know. To speak with a 1031 exchange specialist for free, call 888-872-1031 or request a call online today.